3 Reasons Costco Stock Is Definitely Worth the Price

Costco stock is far from cheap, but the premium is well deserved

As should be no surprise, Costco (NASDAQ:COST) has logged a nice gain for the year, up about 20%. Part of this has been due to the strength of the consumer as well as the overall bullishness of the markets. But then again, Costco stock tends to do well regardless of the environment.

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The fact is that the company is highly disciplined and focused. For the past decade, the average annual return on Costco is an impressive 19.51%. To put this into perspective, the gain for Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) is about 15.59% during the same period!

Now it’s true that the valuation of Costco stock is pricey, with the forward price-to-earnings multiple at a steep 28.5X. Yes, for a retailer, this is really a stretch. However, Costco is no ordinary retailer. The company has several major competitive advantages that should help keep up the performance. If anything, Costco stock is likely to remain fairly resilient if the recent market volatility continues.

So then, what are the key drivers for the company? Well, let’s take a look at three:

Costco Stock: Business Model

The business model for Costco is very simple – but quite powerful. By requiring an annual fee, the company is able to essentially guarantee its profits. This is why Costco is often called the Amazon (NASDAQ:AMZN) Prime for the brick-and-mortar world.

With recurring revenues as a cushion, the company can then focus its efforts on finding ways to provide low prices and quality merchandise for customers. The result is that Costco has built significant loyalty. For example, the renewal rate in the U.S. is an impressive 90%. In fact, the total number of cardholders is 96.3 million.

For the most part, the Costco business model would prove extremely difficult to disrupt. Consider that there are 772 warehouses and an extensive supply chain for thousands of products. Costco has also been able to provide many benefits for its members, such as with cruises, hotels and even car purchases.

Costco Stock: Growth

Even with its massive scale (it’s the No. 2 retailer in the US) Costco is still able to gin up growth. During the latest quarter, total revenues increased by 7.2% and the comparable sales were 6.7%.

Furthermore, the company continues to generate substantial cash flows (they were about $2.7 billion for the past year). This allows Costco to have a strong buyback program – which is at $4 billion – and to periodically pay special dividends.

The company has also been investing heavily in its ecommerce platform and same-day delivery system. In the quarter, the sales from this unit jumped by 25.5% (the company does not disclose the totals).

There have also been other investments in technology. For example, Costco has introduced self-checkout registers and kiosks. There is even a plan to develop a key fob to pay for gas with a single swipe.

Costco Stock: Private-Label Strategy

The Kirkland Signature brand is Costco’s private-label products. They generally have lower prices as well as higher margins.

The Kirkland Signature has certainly become a big part of the business. Last year, the revenues from this segment came to $39 billion, up from $35 billion in 2017.

Keep in mind that Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) considers that the Kirkland Signature business is the most important competitive advantage for Costco.

In a CNBC interview, he noted that the packaged-goods products are taking share away from major operators like Kraft Heinz (NASDAQ:KHC). In other words, The Kirkland Signature brand is probably only in the early phases of the market opportunity.